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valuationThere are five main methodologies used to determine a valuation:

  1. discounted cash flow analysis,
  2. publicly traded comparable companies,
  3. comparable merger & acquisition transactions,
  4. LBO analysis, and
  5. liquidation analysis.

When valuations are high like they are now, buyers and sellers have to shift strategy a bit. High values mean buyers are paying premium prices, so quality is as important as ever. Sellers need to worry about timing and making sure they’re ready to go to market and “strike while the iron is hot.”  But there are a number of other considerations to keep in mind that can determine how high a valuation will go.

Risk

For one, buyers need to look at the number of participants in the bidding process and the range of bids which help to determine the level of risk. Right now, we are seeing rising number of participants with a wider disparity between low bid and high bid.

Fit

Having a strategic fit, such as a strong alignment to a product team, can garner a company a higher valuation. For sellers, defining a products place in the market and how it differentiates itself is key.

Momentum

There are of course multiples in various industries, especially in the technology sector and particularly Software as a Service (SaaS) platforms. These companies may all have consistent, high quality earnings and growth, so buyers are going to look more closely at momentum. Buyers are more concerned about excitement  in the marketplace and demand for the individual product. If performance in the public market is good, it can drive valuations upward.

Efficient Capital

Supply and demand of capital in the market versus companies available to invest in are also going to drive valuations higher.

Right now, there is a large amount of cash reserves on corporate balance sheets both domestically and internationally, so banks are able to aggressively deploy money in an increasingly efficient manner. How much investors get back can then be considered independently from valuations. Allowing for different tranches of capital means they can also have a different risk profiles and rate of return requirements which means investments can potentially come in at lower rates of return that could yield higher multiples overall.

Conclusion

Despite the abundance of money and a welcoming capital market, we are seeing that buyers are more discerning about their targets than ever. Buyers are looking for quality above all else. Big valuations are for companies that hit these key considerations out of the park.